On Monday, the Consumer Financial Protection Bureau (CFPB) announced the latest in a series of five enforcement actions involving military allotments: a $3.1 million consent order against a payment processor, Military Assistance Company (MAC) and its parent, Fort Knox National Company. The CFPB alleged that MAC had failed to disclose to servicemembers the amount of its fees and the fact that it had charged fees. MAC managed a payment processing system that took payments from servicemembers’ paychecks (allotments) and sent them to creditors such as car lenders or furniture sellers. Once the loan was paid off, excess funds would sometimes continue accumulating in a servicemember’s third-party payment processing account, often without the servicemember’s knowledge. MAC charged its allegedly undisclosed fees against these excess funds.

What are allotments, and why does CFPB care about them? As the CFPB explained, “The military allotment system allows servicemembers to deduct payments directly from their earnings. The allotment system was created to help deployed servicemembers send money home to their families and pay their creditors at a time when automatic bank payments and electronic transfers were not yet common bank services.” MAC was one of the largest third-party allotment processors before the Department of Defense (DOD) changed the rules on January 1, 2015, to prohibit the use of allotments to repay loans for personal property (cars, furniture, jewelry, etc). DOD changed the allotment system in response to recommendations from a working group made up of several DOD offices, CFPB (including me, when I was there), and other federal bank regulators.

The CFPB has been concerned about potential harms resulting from abuse of the allotment system for a number of years. In June 2013, Holly Petraeus, the Director of the Bureau’s Office of Servicemember Affairs, outlined the concerns in a blog post. Among other things, she cited the cost of allotments and the lack of transparency and choice.

CFPB focused on all issues that affect servicemembers The other reason the CFPB cares about allotments is that the CFPB, led by Mrs. Petraeus’ office, is focused like a laser on anything that might harm servicemembers. For example, the CFPB takes complaints about and examines for violations of the Servicemembers Civil Relief Act (SCRA) and Military Lending Act (MLA).

The MLA is a complex law that the CFPB has authority to enforce, and the DOD is currently working on a final rule that will significantly expand its scope. Last week I spoke on an ABA panel in San Francisco entitled “Lending to the Military,” and the revisions to the MLA were a topic of great concern – particularly for credit card lenders. DOD has proposed expanding the MLA to cover credit card loans, which would require systems changes at nearly every bank in the country. This is because the MLA (like the SCRA) has an interest rate cap with a complicated definition of interest that differs from the Truth-in-Lending Act’s APR definition. Lenders must review their systems and train their staff to avoid violations of these laws.

Although the CFPB does not enforce the SCRA, its exam manual directs examiners to keep an eye out for potential violations of that law, and the Bureau can refer such matters to the Department of Justice (DOJ). In many ways, the SCRA is significantly more complicated to comply with than the MLA, and DOJ has been zealously enforcing it.

CFPB and banks’ interests are aligned in moving payments to online banking Instead of allotments, Mrs. Petraeus’ blog post encourages servicemembers to consider automatic ACH payments or online bill-payment as a means of repayment, since they are “usually free and easy to set up.” This is a good example of an area where the CFPB is interested in driving more consumers to use bank or credit union services instead of nonbanks. (I previously wrote about another area where CFPB policy changes may have a similar effect: small dollar lending.)

The charges in the MAC order The MAC consent order alleged violations of the Consumer Financial Protection Act’s prohibition on unfair, deceptive, or abusive acts or practices (UDAAP). 12 U.S.C. §§ 5531, 5536(a)(1)(B). In fact, the order found that MAC’s conduct violated all three standards, and there were two separate counts of abusive acts and practices. The Bureau found the conduct abusive because it took “unreasonable advantage of [] (A) a lack of understanding on the part of the consumer of the material risks, costs, or conditions of the product or service; [or] (B) the inability of the consumer to protect the interests of the consumer in selecting or using a consumer financial product or service.” 12 U.S.C. § 5531(d)(2).

Previous cases show a steady focus on allotments The MAC order follows on four previous CFPB consent orders involving lenders that targeted military servicemembers and either required or strongly encouraged repayment by military allotment:

• A December 2014 consent order against Freedom Stores ordering $2.5 million in redress. Among other things, the CFPB alleged that Freedom had “double-dipped” in servicemembers’ funds by setting up most servicemembers on allotment payments, and then requiring borrowers to authorize a bank withdrawal as a backup method. The CFPB said that, “many consumers had their payments taken from both their paychecks and their bank accounts in the same month, often without their knowledge and before the payment due date.”
• A July 2014 consent order against Colfax Capital and Culver Capital (also known as “Rome Finance”), ordering $92 million debt forgiveness for servicemembers. CFPB alleged that, among other things, Rome had hidden the high interest from servicemembers by artificially inflating the disclosed price of the goods (typically TVs and computers) that it sold to them. The lenders in Rome typically required servicemembers to repay by allotment.
• Two June 2013 consent orders against a bank and its nonbank marketing partner, ordering refunds of $6.5 million to servicemembers. The CFPB alleged that the bank and nonbank’s subprime auto loan program required servicemembers to repay their loans by allotment.

CFPB targeting payment processors to prevent harm by smaller entities The MAC settlement is also interesting because it follows on the heels of CFPB’s lawsuit earlier this month against “phantom” debt collectors and the four payment processors that processed credit and debit card payments on their behalf: Global Payments, Pathfinder, Frontline, and Electronic Merchant Systems. The CFPB is focused on the payment processor space because the Bureau has limited resources, and it recognizes that targeting larger players such as payment processors can be more effective than investigating only the merchants and debt collectors, which are often much smaller entities. I suspect that the Bureau thinks that if it can force payment processors to improve their compliance and risk management systems, then the lawsuit will have a wider impact, instead of stopping just one alleged phantom debt scheme.

Nicholas F. B. Smyth is a member of Reed Smith’s Financial Industry Group, where he advises clients on examinations and investigations by the Consumer Financial Protection Bureau (CFPB) and other bank regulators. He can also advise clients on investigations and represent them in litigation by the FTC, DOJ, and state attorneys general. During his four years as an Enforcement Attorney at the CFPB, Nick became an authority on issues that affect military families, including allotments. He helped set up the CFPB’s Office of Servicemember Affairs, and he has presented on allotments at the Army JAG School and to senior AG officials. Nick helped negotiate two multimillion-dollar settlements in connection with a subprime auto loan program for servicemembers, and he served on a Pentagon working group that was created in response. Prior to joining the CFPB, Nick worked on the Treasury Department team that drafted and helped pass Title X of the Dodd-Frank Act, which created the CFPB.

Client Alert 2015-102